As we introduced in our last post, we’ve obtained the rights to share what we feel is an excellent series of articles: Evidence-Based Investment Insights. Here is the second in this seven-part series.When it comes to investing (or anything in life worth doing well) it helps to know what you’re facing. In this case, that’s “the market.” How do you achieve every investor’s dream of buying low and selling high in a crowd of highly resourceful and competitive players? The answer is to play with rather than against the crowd, by understanding how market pricing occurs.
The Market: A Working Definition
Technically, “the market” is a plural, not a singular place. There are markets for trading stocks, bonds, sectors, commodities, real estate and more, in the U.S. and around the globe. For now, you can think of these markets as a single place, where opposing players are competing against one another to buy low and sell high.
Granted, this “single place” is huge, representing an enormous crowd of participants who are individually AND collectively helping to set fair prices every day. That’s where things get interesting.
Group Intelligence: We Know More Than You and I
Academia has revealed that, although the market may seem chaotic, messy and unpredictable when viewed up close, it’s also subject to a number of important forces over the long run. One of these forces is group intelligence, which tells us that the current prices set by the market are expected to yield the closest estimate for guiding one’s next trades. It’s not perfect mind you. But it’s assumed to represent the most reliable estimate in an imperfect world.
Sheri’s note: For additional insights on group intelligence, refer to our SageBroadview post, “On Skittles and Financial Fortune.”
Understanding group intelligence and how it governs efficient market pricing is a first step in more consistently buying low and selling high in free capital markets. It frees you to forgo efforts to “beat” the market’s wisdom and channel your energy into structuring your portfolio according to the science of investing.
But that’s a subject for a future Evidence Based Investment Insight. Next up, we’ll explore what causes market prices to change. Chances are, it’s not what you think.